Budget 2020 – a relief for entrepreneurs?

Business owners and their advisers were expecting reform of entrepreneurs’ relief when chancellor Rishi Sunak delivered his first budget on 11 March 2020. It had been extensively trailed in the media that changes were anticipated.

When it came, the announcement was to reduce the lifetime limit rather than abolish it, which many had widely feared. The lifetime allowance for relief from capital gains tax (CGT) at a rate of 10 per cent was reduced from £10m per person to £1m.

An aspect that was not so widely envisaged was the announcement of anti-forestalling measures, with the chancellor taking the unusual step of introducing those measures with a retroactive effect.

Initial savings

Entrepreneurs’ relief was first introduced under the last Labour government back in 2008. At the time, it was estimated by the treasury that the relief would cost the government £200m. In the first tax year following its introduction, it actually cost government £500m. The latest figures showed it costs between £2bn and £3bn a year.

Earlier this year, prime minister Boris Johnson publicly criticised the relief, stating: “I have to tell you, the Treasury is fulminating against it because there are some people who are staggeringly rich who are using that relief to make themselves even more staggeringly rich.”

The Institute for Fiscal Studies in its own research had stated that 43,000 people claimed £2.3bn in entrepreneurs’ relief last year. Of the £2.3bn, about three quarters went to just 5,000 people who had made gains of more than £1m a year, which meant those taxpayers received an average of £350,000 a year from the tax relief.

From the government’s perspective, the relief was perceived as rewarding people who didn’t need that initial assistance to start their own business. It was politically becoming increasingly difficult to argue that a low tax exit was a positive way of encouraging or helping people to start up their own business.

The counter argument to retaining the relief comes from small entrepreneurial business owners. Many small businesses were originally set up to enable the owners to sell in due course, and use the proceeds to fund their retirement. Many entrepreneurs use their businesses as retirement plans as they are not employed and cannot rely on a company pension scheme.

Arguably, the economic reality supported the abolition of the relief altogether, at a time when small businesses are experiencing unprecedented pressures; but the chancellor took the decision to reduce the limit back down to the £1m level where it had been originally when the measure was first introduced in 2008. The government’s stated intention in reducing the limit is to shift the focus to encourage only genuine risk takers and entrepreneurs.

While the reduction in the limit was not wholly unexpected, perhaps the size of the reduction was; and the immediate implementation of the change will have caught many people by surprise. It is also interesting to note that no further consultations to reform the relief were announced on budget day.

Sting in the tail

Though the headline news focused on the cut in the lifetime allowance, there were some well drafted anti-avoidance provisions that aim to block any tax advantages carried out before the budget, with a view to protecting the entitlement to entrepreneurs’ relief at the previous £10m limit.

Because a change was widely anticipated to entrepreneurs’ relief, many business owners had taken steps prior to the budget to try to accelerate transactions to ensure they sold their businesses on or by 10 March.

They may now be subject to the anti-forestalling measures that were introduced to prevent the benefit of pre-budget entrepreneurs’ relief planning, such as entering into unconditional and rescindable contracts with delayed completion dates.

In the past, this type of planning was used when the changes were anticipated to taper relief. The anti-forestalling measures are intended to not only capture disposals of businesses going forward, but may also capture disposals where contracts have been exchanged before budget day – but have not yet completed.

A common piece of planning can involve carrying out an unconditional disposal to a connected party, but not to complete the transaction until later. Section 28 of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) provides that such a disposal is nevertheless treated as having occurred at the time that the contract was unconditional, which was before 11 March 2020.

For the purposes of determining what the lifetime limit is for entrepreneurs’ relief, this rule will not apply and the transaction is treated as occurring on or after 11 March 2020 when the transaction is actually completed.

This means that the transaction is treated as occurring before 11 March 2020 in terms of determining in which tax year a capital gain arises, but the lifetime limit applicable to that transaction will only be £1m, not £10m.

There are two exceptions to the above rule: If there is a disposal to unconnected persons and the delayed completion was not intended to take advantage of section 28 of the TCGA, the original £10m limit can still apply.

If the disposal is to connected persons, the £10m limit can also still apply, provided the contract entered into was for ‘wholly commercial reasons’ and was not intended to obtain a tax advantage by virtue of section 20 of the TCGA. The conditions for this second exception are therefore more onerous than the first, as the reasons for the transaction have to be wholly commercial.

Legislation will be introduced requiring taxpayers to make a specific statement in their tax returns that they had ‘no purpose of obtaining a tax advantage’. No doubt HMRC will be looking closely at tax returns submit- ted claiming the £10m relief.

Clearly, there will be ‘innocent’ business owners caught out by these anti-forestalling rules as they may not reflect real-life decision making which was taken by them prior to the changes being announced. The retrospective application to uncompleted contacts arguably is an extension by the government in its use of retrospective tax legislation to tackle avoidance, which will no doubt become a regular feature in future budgets.

Future impact

I suspect that the change in itself is un- likely to have a significant impact on the UK economy, on the assumption that the majority of entrepreneurs do not establish new businesses for the sole purpose of securing a favourable CGT treatment on exit.

Therefore, I don’t see this as having a negative impact on the number of new businesses being established. There may be future announcements where measures

will be specifically targeted at assisting early stage businesses and moving the focus away from exit.

A targeted approach would be welcome for those start-up businesses which will have a reasonable chance of success and which, in turn, will assist in growing the UK economy.

Matthew Duncan is a partner at Druces druces.com